How to sidestep those payroll tax pitfalls

According to some critics, instead of exempting workers who "customarily and regularly exercise discretionary and independent judgement," the new definition is broader and incorporates people who "hold a position of responsibility." The definition of exempted professionals has expanded to include not only workers with advanced degrees or postgraduate study, but also those with special work experience or training.

Controversial as they are, the new regulations have focused attention on the complex payroll withholding system that every dermatology practice must deal with. In fact, many of the withholding rules are also contained in old statutes. The question is: Do you understand the withholding issues as they apply to your dermatology practice?

Naturally, the term "employee" must be distinguished from an "independent contractor" for purposes of employment tax obligations. An employer is not required to withhold taxes on payments made to independent contractors. A common law definition of "employee" focuses on the control that is or isn't exercised over what is done and how it is done. The Internal Revenue Service even uses a 20-factor test to assist in determining of whether a worker is an employee or an independent contractor.

Under the Federal Insurance Contributions Act (FICA), an employer is required to withhold social security taxes - including hospital insurance tax - from the wages paid to an employee during the year. What's more, the practice must also match the amount withheld from the employee's wages. In 2003, the combined tax rate was 7.65 percent, consisting of a 6.2 percent payment component for old-age, survivors and disability insurance (OASDI) and a 1.45 percent component for hospital insurance (Medicare).

The OASDI rate applies only to wages paid within an OASDI wage base ($87,000 in 2003 and $87,900 for 2004). There is no cap on wages subject to the Medicare tax.

Another law, the Federal Unemployment Tax Act (FUTA), imposes a tax on employers who employed one or more persons in "covered" employment. In this case, "employer" is defined as a dermatology practice that had workers who were employed at least one day in each of 20 weeks during the current or preceding calendar year, or who paid wages (in covered employment) of at least $1,500 in a calendar quarter in either the current or preceding calendar year.

The FUTA unemployment tax is based on the first $7,000 of wages paid during the calendar year to each employee. The full rate of the tax is 6.2 percent, but the employer is usually allowed a partial credit against this tax based on its state unemployment insurance tax liability.

Filling out forms and filing Not only must every practice withhold income taxes, Social Security, and unemployment taxes from the wages and salaries paid to workers, and match the Social Security amounts withheld, they must also report these amounts to the government - as well as pay over the withheld amounts, of course.

An employer that is subject to either income tax withholding or Social Security taxes or both must file Form 941 (Employer's Quarterly Federal Tax Return). That return combines the reporting of income and FICA taxes withheld.